Inflation is running at a faster pace than the Federal Reserve anticipated earlier this year in its policy report to Congress.

At that time, members of the Federal Open Market Committee projected that the consumer price index would rise by 2 1/2% to 2 3/4% (as a central tendency) over the course of 1993. For the first four months of this year, however, the CPI has in fact risen at about a 4 1/4% annual rate.

Though the Fed's price outlook was not represented as a policy target, it was certainly consistent with the avowed objective of continuing to move toward price stability.

In that sense, policymakers must have taken great comfort from the projection. Thus, recent price performance has to be a cause of some unease.

Current Policy Adequate

Whether it should be a cause for tightening monetary policy at this point in time is another matter, however. There are a number of reasons for shying away from a tightening.

The demand for goods and services is lackluster, and the outcome of the budget deficit deliberations is still uncertain.

Moreover, there is still some hope that price increases will slow in the months ahead. It is, however, very unlikely that they will decelerate enough to meet the Fed's projection for the year.

In any event, it is not at all clear that the Fed, or other major central banks for that matter, should strive to repress inflation significantly further under current circumstances.

Taming Inflation

One of the reasons for the prolonged economic slump in the industrial world was the much-needed effort made by central banks to bring inflation down from earlier highs and to promote price stability.

As long as one is not a purist in these matters, that effort can be considered a success, with consumer price increases for major countries generally in a 1% to 4% range on a year-over-year basis.

The success in repressing inflation has laid the groundwork for sound if unspectacular growth in the future by forcing businesses to cut costs, restructure for greater efficiency, and get their finances in order.

U.S. business activity has responded modestly and has been expanding for two years now. European and Japanese businesses have lagged behind.

However, monetary authorities abroad are now reorienting policies toward growth, though slowly in countries such as Germany, where there is a residual inflationary problem.

While it is reasonable in current circumstances for U.S. monetary authorities not to risk stymying the economy by attempting to repress inflation further, the more difficult question is how much of an upcreep in inflation should be tolerated.

Somewhat more inflation this year than the Fed initially projected should not be a great problem. The Fed's projection was perceived by the market as overly optimistic to begin with, and an overshoot of modest proportions would not significantly diminish the Fed's credibility.

Risk of Spiraling Prices

Too great an overshoot would, however. And if credibility begins to erode, the risks would become much greater that inflation would tend to accelerate through a familiar price-wage-price spiral.

Thus far, there is no evidence that the recent acceleration in prices will be sustained or that it is encouraging significant wage pressures. Nonetheless it is very unlikely that this year will see a repeat of last year's less than 1% rise in unit labor costs.

An acceleration from such an unusually slow pace is in the cards, but labor cost pressures have not yet become strong enough to push prices up.

Tightening Needed Later

Sometime before the year is out, though, it seems likely that the Fed will need to give a sign of its determination that inflation should not accelerate significantly.

That need would be most evident when the pace of real growth recovers from its recent lull and when it becomes clear that at least narrow measures of money are growing with some rapidity on a sustained basis.

If the Fed were to act when conditions became reasonably compelling, a small move might suffice to ward off any threat of an undesirable price-wage interaction and would have little, if any, adverse effect on growth.

However, if the Fed failed to act, the reaction in financial markets might be adverse enough itself to unsettle the economy.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.